Calls for e-commerce and cloud computing goliath Amazon to spin-off AWS, its fast growing cloud computing business, have been growing for some time now. The argument is that while Amazon’s foundational e-commerce business is huge, accounting for around 40% of e-commerce sales in the USA and 4% of all retail spend in the world’s biggest economy) its growth has slowed and it’s also a low margin business. At the same time, while AWS will account for less than 20% of Amazon revenues this year, it is expected to contribute all of its income.
A recent 128-page report by Redburn analysts Alex Haissl, kicking of its coverage of the cloud computing sector, argues the pace of AWS’s growth compared to the e-commerce business strengthens the argument in favour of a spin-off. AWS’s revenues grew 37% to $18.4 billion in the first quarter and operating income grew 57% to $6.5 billion. Over the same quarter, the e-commerce business contracted as economies opened up after Covid restrictions.
The odd-on likelihood of a global recession is likely to keep the pressure on Amazon’s huge but low-margin e-commerce business. The company is also making huge capital investments in automating its warehouses, robotics that could one day mean parcels are dropped off by drones and robots rather than humans, its 1-day deliveries promise and new businesses like online groceries and pharmaceuticals.
Nobody is questioning the overall, and especially long-term, strength or viability of Amazon’s e-commerce business. It is a juggernaut unlikely to be seriously challenged, at least in the West, anytime soon. The massive capital investment being made in the business now is reinforcing the moat it has built up around its dominant market-leading position. And the overall value of the e-commerce sector is still tipped to grow significantly.
Retail e-commerce sales worldwide from 2014 to 2025(in billion U.S. dollars)
Source: Statista
However, the cloud computing sector is still at an earlier and higher growth stage of its evolution when compared to e-commerce, which has matured significantly over the past decade or so. The global cloud computing market size is expected to grow from $445.3 billion last year to $947.3 billion by 2026, at a Compound Annual Growth Rate (CAGR) of 16.3% during the forecast period. In the USA, by far the largest and most mature international cloud computing market, annual CAGR is expected to be almost 15% between now and 2030.
Source: Grand View Research
And AWS’s market share of the global cloud computing market is almost as dominant as its share of e-commerce spend, at 33% compared to the 21% held by its closest competitor, Microsoft’s Azure.
Source: Statista
AWS’s business is also much higher margin than Amazon’s e-commerce operation, which is why it is powering the company’s profits. The way Amazon reports its performance makes it difficult for analysts to get a precise picture of margins across different businesses. But it’s generally accepted the company makes little to no money on its first-party sales.
It probably does make reasonable margins on its marketplace business that lets third-party retailers sell through Amazon with logistical support in return for a fat commission. And earlier this year it was announced its advertising business is now worth a massive $31 billion and is probably now its most profitable. That wouldn’t exist without the broader e-commerce business.
Whatever the exact margin and profitability breakdown between its units, Amazon can afford to continue to invest huge sums in its e-commerce and physical retail businesses and will undoubtedly do so.
But if, as Haissl writes in his report, “the performance gap versus the non-AWS parts continues to widen”, spinning AWS off as an independent company may be an option that starts to gain support at board and key investor level even if it’s not on the table right now. Especially if the cloud computing business makes significant progress toward the $3 trillion value Haissl thinks it is heading for, without providing any concrete timelines for when that might be achieved.
Would AWS already be worth more than Amazon right now?
Having seen its share price drop by 38.5% over the past 12 months and 33.7% this year as it has been caught up in the broader market and growth stocks sell-off, the company has a current market capitalisation of $1.5 trillion.
It’s still one of the handful of most valuable public companies in the world, behind only Apple, Microsoft, Alphabet and Saudi Arabia’s state-controlled oil company Saudi Aramco. But many analysts are convinced AWS would be more valuable than the whole group, including the world’s dominant e-commerce business, as a stand-alone company.
Bloomberg Intelligence analyst Anurag Rana believes AWS would be worth $1.5 and $2 trillion today as an independent company, compared to the $1.15 trillion the market values the combined entity at today.
Should investors buy Amazon stock to profit from an AWS spin-off at a future date?
While it’s not unlikely at some future point, there aren’t currently believed to be any serious conversations happening around spinning AWS out, which would mean existing shareholders being given stock in the new company relative to their ownership stake in Amazon. So it wouldn’t necessarily make sense to invest in Amazon with that in mind.
However, at its current valuation, and considering the perceived stand-alone worth of AWS, the Amazon share price is seen as great value in many quarters. Haissl’s admittedly extremely bullish target, the highest on Wall Street, is for the Amazon share price to hit $270 in the next year compared to its current level of $113. That would represent an upside of over 150%.
The more mainstream consensus for potential Amazon upside is still very attractive. Of the 44 analysts covering the stock polled by CNN the high end of consensus targets is for $215 and the median $175.00. 41 analysts rate the stock as ‘buy’.
Amazon does currently look oversold and a bargain at $113. Even if AWS isn’t likely to be spun out imminently, its contribution to the company means it’s hard to see the Amazon share price not gaining significantly from its current levels whenever negative market sentiment begins to ease. And if it is one day, Amazon shareholders could benefit from a bonanza.
